Monday, 22 September 2014

Misleading a country

When this happens (taken from a post by Jérémie Cohen-Setton), something has gone very
wrong. The Euro was meant to increase growth, not create stagnation. So what,
or who, is to blame?

Many outside the Eurozone, and a growing minority within it,
will say the Euro itself. But that is not a very helpful response. Given the
level of commitment to the Euro, it is the only
correct response if there is no version of this currency union that can be made
to work better.

Others will say that the only way forward is further political
integration through a fiscal union. That seems like the political equivalent of
going from the frying pan into the fire. The story of the Euro is as much a
political failure as an economic failure. But I also suspect support among many
economists for fiscal union is built upon a questionable premise. The premise
is that the current difficulties arise because it is inevitable that Germany
will put its national interest above the interests of the Eurozone as a whole.

This argument goes as follows. As a result of undercutting
other union members, Germany has become too competitive within the Eurozone.
This will be reversed. The ECB has an inflation target of almost 2%. Therefore
in normal circumstances we would see inflation above 2% in Germany for some
period. This is unfortunate for Germany, but those are the macroeconomic rules
of the game in a monetary union.

However we are not in normal circumstances, because the
interest rate set by the ECB cannot fall any further. As a result, Eurozone
inflation is well below 2%. There is an obvious solution to this problem:
replace monetary stimulus with fiscal stimulus. However, this is not in
Germany’s interests: as a result of becoming too competitive, their economy is
relatively healthy, and they do not want above 2% inflation. Therefore we need
a fiscal union to impose fiscal stimulus on Germany. (There is a variant of
this argument where we focus on the failure of monetary policy and German
pressure on the ECB.)

It is natural for economists to reason this way, because we are
used to thinking about rational self-interested individuals. But suppose the
problem with German public opinion is not that it is being narrowly
self-interested, but that it has been encouraged to think about this in the
wrong way. There are two aspects to this. First, although Keynesian economics
is taught in all universities, in appears taboo in much German public discussion. Under
this anti-Keynesian view the chart above has nothing to do with fiscal
contraction, so it must be all about the lack of ‘structural reform’ outside
Germany. Second, German politicians are in denial about the implications of low
German inflation before the crisis. Logically the only way Germany can avoid
above 2% inflation is if the Eurozone as a whole goes through a prolonged
depression, but as is painfully obvious from the comments on some of my recent
posts, the German public is not told about this.

The two deceptions help reinforce each other. Germany says it
is doing OK without the need for fiscal stimulus, so why do other countries
need it? Of course Germany is doing fine because its period of relatively low
inflation allowed it to uncut its Eurozone competitors.

Never underestimate the power of bad ideas, particularly if
they have ideological roots. Here we have the two mistakes that led to the
Great Depression being repeated. We look back at the 1930s and think if only
they had known about Keynesian economics a depression could have been avoided.
However the depression was as much about countries attempting to stick with the
gold standard, and the problems with that were obvious at the time. Today we do
know about Keynesian economics, but both mistakes continue.

It is possible to believe that balanced-budget fundamentalism
is somehow hard wired into the German psyche, and I have personally experienced
moments like that described in this comment to my earlier post that seem to
confirm this. So I do not want to discount such explanations entirely, but I do
wonder if a powerful motive behind this is just the same anti-state
neoliberalism that you see elsewhere. Those on the right appear to have a
greater distrust of economists and their theories. This may be true of popular attitudes (HT Tyler Cowen), but it is also the
case of those running the country.

According to Der Spiegel, the three permanent
secretaries running the German finance ministry have studied law rather than
economics. Among the nine department heads seven are lawyers and just two are
economists. While the balance between lawyers and economists has always
favoured lawyers, it has apparently become worse under Schäuble (whose
doctorate is also in law).

As a result of all this, it is not at all clear to me that the
current problems of the Eurozone are all down to German self-interest. The case
for additional infrastructure spending in Germany looks strong, as argued
by Marcel Fratzscher, head of the German Institute for Economic Research (DIW).
It would therefore seem more than possible to get Germany to take part in a
Eurozone wide programme of additional public investment, which can be justified on a microeconomic/supply side basis
as well as on macroeconomic/demand side grounds. All that stands in the way is
the power of bad ideas, and its embodiment in the Eurozone’s fiscal rules.

83 comments:

Solving the euro problem without breaking up the currency and without forcing Germany to accept transfers and / or higher inflation is possible. Less competitive countries should issue tax credit certificates (a kind of parallel national currency) to reduce taxes on labor AND to expand internal demand. See this http://www.economonitor.com/blog/2014/07/which-options-for-mr-renzi-to-revive-italy-and-save-the-euro/and thishttp://bastaconleurocrisi.blogspot.it/2013/09/tax-credit-certificates-certificati-di.html

Dear professor,Thank you for the post. I enjoyed it immensely while reading it. I must ask you beforehand not to judge me too harshly for the comment I'm about to write here, I'm neither qualified nor knowledgeable enough to comment on your article and it wasn't intended as a criticism in the first place.

Consider it as a sharp-tongued student question: It's just that I can't write anything which doesn't involve a healthy dose of cynicism :) I just can't write in any other way... Anyways here it goes :)

***

Sir, I'm asking you, which lack of "Fiscal Stimulus" we're talking about here, exactly? The Public Debt/GDP levels of EU countries (Spain, Italy, Portugal, etc) are clearly on a huge lower left to upper right trend since 2008 crisis. For most countries, the government spending never ceased to grow on an absolute level, practically since... forever!

So, most of the EU countries never actually decreased their spending per se, did they? On the contrary, they boosted their spending hugely as a response to 2008 crisis, like every other government on the planet.

So indeed, they tried fiscal policies (to the point of recklessness some might add, from a historical point of view) yet it didn't work and here we are. So we must be talking about a "not enough stimulus" argument instead of "lack of stimulus" here, since there wasn't a real lack of it in the first place.

So basically, is this what you're saying here? "Hey EU, I know you pumped enormous amounts of money in response to crisis, and believe me it was the right thing to do, but you just can't stop now. I know some of you are worried about the debt levels being unsustainable, but you need to continue pumping fiscal stimulus to fend off stagnation"

***

Again, I must apologize for my sharp-tongue. I just can't hold myself, I don't know any other way :) The point of the whole comment was meant to learn something from you.

Deficits automatically rise in recessions - that is not policy. To look at discretionary policy, you need to look at the underlying (cyclically adjusted) primary deficit. In the Eurozone this was tightened by 3% of GDP between 2009 and 2012 (OECD estimates) - a very large fiscal contraction. This contraction continues. The European Commission estimate that the level of Eurozone GDP is about 4.5% lower in 2013 as a result: see

1. misleading graph: the period of just 8 years between 2000 and 2007 is not showing a trend, but a boom, fueled by several unsustainable policies that might not come back anytime soon. Where is the new sustainable growth supposed to come from in some of these troubled countries?

2. ''Germany says it is doing OK without the need for fiscal stimulus, so why do other countries need it?''No, this is not the main point. Germany may or may not believe in need for fiscal stimulus, but they wouldn't care what other eurozone countries would do as long as they do not need to foot the (long term) bill. Germany (and others) are afraid they will need to eventually pay for the increasing government debt of a country like Italy.

3. Why are Keynesian economists so in denial about the need for structural reforms in some countries? Maybe because they live in countries without for example any serious job protection and therefore the market forces structural reforms? Are they unaware this is completely different in the troubled eurozone countries?

4. Please show us some proof that an inflation of 2% in the eurozone would solve the problems of the troubled countries. I assume according to your models it would increase competitiveness of deficit countries, I doubt this would be true. First, it would not increase competitiveness compared to outside eurozone, second it does not take into account how surplus countries would react. Your model probably tells you that wages in surplus countries would increase, but that does not take into account the tradition of wage moderation unknown in anglo saxon economies (BTW: wages in UK also didn't keep up with inflation). Thirdly, if you look at the large differences in wages between North and South, I find it hard to believe that wages of deficit countries are too high compared to surplus countries. But if you compare wages in deficit countries with Eastern Europe and Asia, than it looks more obvious why they can be perceived as too high. The problem is not just between North and South, it's more complicated: Surplus countries managed to increase exports outside eurozone (Asia etc) and the earned surplus money was invested in the troubled countries (housing bubbles). As this has proven to be unsustainable, this money flow will not come back. And now the troubled countries need to regain competitiveness compared to manufacturing of low wage countries outside eurozone or find new niches to earn money with. All has little to do with North.

I continue to see the analysis of this blog of ''my model shows there is a demand shortage, put some money to work and this will eventually sort out the lack of growth problem'' much too simplistic or even dogmatic.

You talk about troubled countries, but pretty well every other country in the Eurozone is in trouble. I am not in denial about the need for structural reform, but it did not cause this recession. What caused it was fiscal contraction throughout the Eurozone - that is what the European Commission's own analysis says:

''Therefore we need a fiscal union to impose fiscal stimulus on Germany. ''

I never heard this argument before. The argument for fiscal union is not about spending in Germany, but about transfer payments from Germany to deficit countries to compensate for structural trade imbalance, smoothen wealth differences and to help overcome economic shocks, like happens in for example the US.

I find this fact (that you haven't heard this argument before) mind-boggling, as a multitude of economists, and some very prominent ones (Krugman, De Grauwe etc) with widely read columns, have been making this point for almost 9 years now.

I also know of at least one Southern European country, where everybody is practically begging German companies and the German government to raise German wages for at least a decade now, and where the inflation differential and the diminishing share of German investment inside vs outside the EZ, is featured frequently in the press. Not to mention that since noone understands why exactly the German government and companies don't use or give their money (a huge CA surplus) on their people in accordance to their productivity, conspiracy theories that this is done deliberately by the German government (impoverish Germans) to force German domination (beggar thy neighbour etc) on the EU, have come to sound plausible to a lot of people.

"Not to mention that since noone understands why exactly the German government and companies don't use or give their money (a huge CA surplus) on their people in accordance to their productivity, conspiracy theories that this is done deliberately by the German government (impoverish Germans) to force German domination (beggar thy neighbour etc) on the EU, have come to sound plausible to a lot of people."

People who apparently don't understand that government has no place in wage negotiations between labour unions and business associations in Germany. At best, it can set the mood.

German labourers wanted to become more competitive to gert rid of high unemployment numbers. They have given up on wage growth for a time to become cheaper vis-a-vis the rest of the world. Apparently, Germany must walk a narrow ledge, for otherwise it will either be the sick man of Europe or attempting to impose a 4th Reich. Preposterous!

This is competition between workers in different countries for employment. Either workers in troubled economies agree to wage cuts themselves or they get to "enjoy" mass unemployment. The choice is theirs, right?

Also the people who make such accusations should understand that with this huge CA surplus equally huge capital net exports came along. I am pretty sure that said countries wouldn't want to miss out on these investments. (Remember Target2?)

Hartz reforms didn't just "set the mood", and lower unemployment came through the high inflation in the rest of the EZ relative to Germany, and not the Hartz reforms per se (if the rest of the EZ followed your example at the same time, the results would be that Germany would experience the exact same recession Spain experiences now).Your third paragraph is exactly a mercantilist view of the world, which equates exactly to beggar thy neighbour when in a locked currency union. You think it's a zero sum game. I won't name the country, because the minute I say 'Spain' or 'Portugal' or 'Greece', that exact minute the discussion will immediately turn on racial stereotypes and not the data. Suffice to say, that in all these countries, a) wages and productivity rose hand in hand, productivity gains in some of them were much bigger than those in Germany in the pre-crisis years (the same time-period) and b) the huge inflation they went through relative to Germany, was a matter largely out of their control for many reasons which I'm frankly just bored to repeat again here, but you can immediately see the systemic aspect of it when you look at the CAs of countries like Greece (high government debt, deficits) and Spain or Ireland (the smallest government debt in the EZ, the only countries with surpluses) and their trendlines are almost *exactly* the same. The end result though was a production boom in these countries, that had to be consumed internally, because the North just wouldn't participate in any other way than adding fuel to the fire.

A very interesting column, and as usual some stimulating comments. Anonymous (22 September 2014 05:31) makes some interesting points, as does Sr. Cattaneo. I know a little about Italy and the labour market there is a complete mess.

Whether this is caused or affected by the very large number of worker cooperatives I am not sure, but the role of the "Permanent Job" seems to be a drag on productivity. Jobs are often allocated based on political affiliation or family ties (eg father retires to give job to son).

Workers on Temporary contracts are very often forced to work as "unofficial" employees (on the 'black') and this might make the underlying lack of productivity appear less extreme as they are not reported as having jobs so pay no taxes either, thus increasing government debt.

The role of the black economy must be taken into account when looking at italian Economics as it is endemic and not small; just try getting a receipt for petrol bought in a country petrol station! This lack of regard for the role of the state goes right through Italian society, from the lowest paid to those providing Professional Services, Healthcare and more. There is a lot of over-employment in government related institutions too.

Applying models that work in countries with 'normal' systems will miss a lot of the problems and make assumptions that just don't apply; not everywhere is the US or UK with a system that works with logic that is applicable and with numbers that are accurate.

If you want to convince the surplus countries, and their voters, to get rid of the strangling fiscal rules you need to convince them there is no way they will ever need to pay for debts of deficit countries. But we both know you can't give them that guarantee.

Let's assume we go back to the Lisbon treaty no bailout clause, dismantle the ESM and forget about banking union.Even if you would do the above, you still need the ECB as the lender of last resort, which means the surplus countries will take on risks.If the markets are not convinced that the surplus countries will at least underpin the eurozone, either via the ECB ''whatever it takes'' action, or any debt programs like the ESM, than the fiscal crisis will come back.But the surplus countries will not write what they see as a blank check, they want rules in return for financial guarantees, whatever the shape or form. According to you these rules are self defeating, but what alternative guarantees can you offer the voters of the surplus countries?

Unless you have a solution for this paradox, all your banging on about Germany is futile.

If you are worried about the ECB applying OMT to an insolvent government, then the focus should be on the procedure and criteria the ECB uses when deciding to apply OMT. That would be productive. Insisting that perfectly solvent governments undertake austerity policies is not.

Japan cannot be bankrupt to its own creditors. Japan was wise to ignore Anglo Saxon theory which asserts things open borders to capital flows and trashes infant industry protection arguments. Where they made a mistake was to listen to the Americans (mind you they were forced to) which pushed them at the 1985 Plaza Accord to deregulate their internal financial markets and initiate monetary easing. Did they not pay a big price?

It is indeed difficult to see a way out of the Eurozone crisis until the world enters a new period of general inflation. But there will be a way out because things do stop: just as the UK recession is finally coming to an end despite (some may say because of but I definitely disagree) the semi-deflationary policies carried out by the UK government so the Eurozone depression will come to an end, even in the absence of proper policies at European level. Of course, the end could be due to collapse, like the earlier efforts at exchange level coordination, but not necessarily. One lesson of the current crisis, in comparison with that of the thirties, is that governments and electorates can be very tolerant of unemployment under certain conditions.

But how has it come to this. Some saw at the time, and it has become increasingly clear in retrospect, that having created the euro with a no-bailout clause, and therefore no mechanisms for bailout, the big error was at the start of the crisis when it 'was decided' that there must indeed be bailouts - but under penal conditions. What was also whispered at the time, and has not been denied, is that the primary beneficiaries of the bailouts were not the sovereign states, which have to pay those expensive loans back, or their populations, which have to surrender their purchasing power, but the lenders, safe in other parts of the zone or even outside it. If the Landesbanken and the British and French (and probably other) banks had taken the 'haircut' that their borrowers' economies should have forced upon them history would have been very different, and politics too, at least in Germany.

So the only solution is indeed to persuade Germany - politicians and voters - that, as Keynes said in a rather different context, fair is foul for foul (in the German case inflation) is useful and fair is not. As I've said before, once they try a bit of leisure and spending, they might even enjoy it.

Good slogan, poor economics (and economic history). Think about it: inflation is actually a tax on those holding liquid financial assets (cash) in favour of those with desirable or productive assets (e.g. land but also labour). The 70s were not a great period for anyone, but worse - relatively - for the cash-rich than for the owners of productive assets including skills.

"Good slogan, poor economics." So you think Piketty is a poor economist - he said that about inflation being a tax on the poor.

And you seem to think that pensioners and recipients of welfare benefits are "owners of productive assets including skills."

Pensions, welfare benefits and salaries are usually adjusted with a time lag. Cash-strapped governments try so keep adjustments below the inflation rates. So as long as no full adjustment takes place, it is a tax.

And most people who are cash-rich are told by their bankers to invest their money in real estate or equities to avoid the disadvantages of inflation. That does not happen to people who need the greater part of their cash for consumption.

Piketty certainly does not make that point, certainly not in the very black and white fashion you do. We do not live in a two time period world, so I fail to see how the time lag point is relevant. There are distributional consequences to inflation but it is quite obviously not just "a tax on the poor".

It is indeed true that even if economists don't always get it right, lawyers dabbling in economics nearly always get it wrong. The problem is that while some economists can sometimes be persuaded by some combination of evidence and logic, lawyers, specifically administrative lawyers (a specialisation almost unknown in the UK) are trained to be impervious to either evidence or logic but simply to be faithful to the texts, or their interpretations thereof. I first realised this when trying to persuade the (lawyer) head of an economic section of an economic Ministry to evaluate his programmes. His response: "It's not for an official to evaluate (second-guess) the objectives laid down by the political function. And since all German officials work according to correct rules and procedures there is nothing to evaluate concerning the process!" Views on that point may now have changed but the underlying philosophy lasts a long time.

The relationship between Germany and Italy can be likened to that of London and, say, the North East of England. In a currency union, with low inflation, there is no way that the North East can compete, except through internal wage repression - which the North East is seeing, but to a lesser extent than Italy. Without money transfers from London to the North East, the economy would sink - even as the London economy suffers to due lowered demand for its products in the North East. Germany would expect London to demand that the North East should reduce pensions and other benefits in the name of fiscal rectitude. That is intolerable, at least for now, in a nation state.

Do yourselves a favour and have a read of this http://www.levyinstitute.org/files/download.php?file=wp_778.pdf&pubid=1912 .Without ONE central Treasury to SPEND, that is "ISSUE", new Euro "units of account" into existence, there can be no effective "EU fiscal policy" capable of stimulating the Euro-zone economy. The ECB has to work with a Balance sheet, just like the BoE. Its assets (member state bonds etc) are bought with Euros it issues from the bottomless pit of Euros the Treasury allows it to access. When it does a lot of the latter we call it QE. Swapping long term to maturity interest paying bonds, for instant spendable cash notes; a "liquidity" injection.

The Treasury is not constrained by any balance sheet. It can create Euros out of thin air and taxes send them back into thin air. The Treasury has to spend before it can tax, else there would be no "units of account Euros" to pay the taxes with. Taxes are used to control aggregate demand, they don't physically pay for anything. The Treasury eventually gets all its spending back via taxes. At any moment the USERS of the currency (the private sector households and firms and any entity that is not the Treasury or the BoE / ECB), hold on to a lot of it for various and personal reasons. We call that "saving". Politicians call it the "national debt".

The Euro is a fiat currency and like all "sovereign" fiat currencies (Pounds Dollars etc), they come from a bottomless pit of such "units of account". Fiat currencies are not convertible into anything except fiat currency. They are the same as a scorecard of a round of golf; the scoreboard at any sporting competition.

Commercial banks make loans (Credit) to people they think can pay it back. The loan creates a deposit (a liability for the bank, an asset for the guy who takes out the loan). About 95% of what we call "money" is commercial bank credit, numbers in spreadsheets; a scoreboard. You can exchange your credit deposit for Treasury / BoE "units of account"; Pound Stirling crispy notes if you want; but, you can't convert those crispy notes into anything that doesn't have Pound Stirling written on it.

Remember. When the private sector stops spending, the government sector has to start spending to maintain the production capability of the economy. The last thing the UK economy needed in May 2010 was "austerity". The last thing it will need in 2015 will be more "austerity". I pray that one day we will get a bunch of politicians, that actually understand how a fiat currency economy works and that we are no longer on the Gold Standard.

. The lawyer to economist ratio is a fine point and should be expanded to include elective office.

Here is the USA, there are very few economists in elective office. Lawyers seems far more likely to hold such positions, especially the Office of President. This appears to be a widespread situation.

What is needed worldwide is for all the competent economists to run for office. The most well known and widely followed should run for the highest offices.

At the very least the discussion would improve, and, I think there is a high degree of probability that the voter would respond to a well argued economic policy based campaign.

The economy is probably the voters' highest priority. It seems like a perfect fit for the best economists to run for office. You would not ask an economist to defend you in court, so why do we ask lawyers to make economic policy?

Back in early 1990, a friend and I made a simple corner-of-the-table calculation based on an ICOR concept: what would it take for West Germany to bring East Germany to its own level of development in 10 years (Helmut Kohl was talking about 10 years)? Our answer was more or less a swing amounting to DEM 100 billion in the West German current account (corner-of-the-table calculations can be useful at times...). On that basis, I went full speed for a monetary union, including Italy. As expected, the French current account was swinging as well, and all the pieces were falling into place, including Germany, now reunified, which was clearly somewhat weakened by its internal effort. This was giving France time to adapt to a low inflation regime. Among the many "Galgen Humor" - I use the term with full knowledge of its origin - aspects of the time was one that bears reminding: France's public debt at the time of the Maastricht treaty negotiation was less than 40% and expectations for GDP long term growth were in the neighbourhood of 3%... Little did we know.

In any case, for peace in Europe in our time, we were prepared to do anything, sacrifice even our beloved currency: the single most important image I remember of the times is Mitterrand and Kohl holding hands over the Verdun killing grounds, not the destruction of the Berlin Wall. The Berlin Wall was bad, sure, and we paid lip service to that, but deep down for us it was well deserved punishment and security for France (love Germans so much we are delighted to have two Germanies, you know who said that in the fifties). And I read "the economic consequences of peace" in the early eighties...

But then, through the nineties, the EC now the EU went into an enlargement overdrive, first to 15 and now to, is it 27 (?), countries and this was spearheaded by the UK and the Netherlands. And the EU became essentially ungovernable is is now totally out-of-control with loonies such as Barroso (ok, there is a new Commission, I'll not pre-judge, but tose nice Ukraine nationalists, you know), not to mention the Baroness. This incidentally explains the French vote on the EU in 2005.

However, what also happened during the nineties was that the Eastern Länder were brought up to a decent development level thanks to that DEM 100 billion swing in the current account that I mentioned in starting. And, meanwhile, those 10 years were not really used by France to implement reforms - read structural - when the going was still good. And then we have Schröder who essentially says, ok, the Eastern Länder are now more or less dealt with, let us return to our usual regime of very low inflation and current account surplus. And that is what Germany did, exploiting new market opportunities in Asia when we French were discussing the dangers of China joining the WTO.

I do think that the Germans also have this history in mind when they tell the rest of Europe - especially France - to reform and even though, as Keynesians, we know that these consolidation policies are wrong right now, we should also be very conscious that the Germans know just as well that we did not consolidate when the time was right. It is thus quite comprehensible in my view that they would be very reluctant right now because of all these breaks that they gave us over past decades that we never really took opportunity of. Things are not that one-sided.

Let's face it: the EU remains is a union of Nations rather than the Federation some of us were wishing for. In this context, why would Germany change policies that have served them well, even though there is an aspect in this which I would loosely relate to the fallacy of saving and paradoxes emerging from a transition from micro to macro (probably not expressing right, I am not an academic after all, but I am sure that you know exactly what I mean...)?

Given that Germany increases its government expenditures via investment in infrastructure. How much unemployment in France, Italy, Spain and Greece will be reduced by this fiscal stimulus? More direct: How large or small is the fiscal multiplier of a German stimulus on aggregate demand of these countries??? Very, very small! Will Germany get a higher rate of inflation as long as there is still unemployment ? Perhaps in connection with a depreciating Euro which will lead to imported inflation and increased export demand for German products. However, that will also agravate the imbalances within the Euro-zone. It looks like replacing one evil by another.

"What is needed is higher public investment in all Eurozone countries."

Oh, now you tell us!

A couple of days ago, you said:

" If Germany produces below average inflation within the Eurozone (for whatever reason), it will have to experience above average inflation at a later date. The ECB's inflation target is 2%.... You cannot escape having above 2% inflation, except by allowing the rest of the Eurozone to remain in a liquidity trap recession."

Ok Great! Then Germany is not supposed to be the locomotive. France, Italy and Spain should do fiscal stimulus by deficit spending and they should try to get the money from the capital market. What would happen to the spread of interest rates? Will the ECB accomodate? Would that "expenditure shock" have a lasting effect on long run output growth ? No! Why? Because neither labour productivity nor technological progress will rise. Output will increase and after a year or two the economies will return to their long run steady state growth rates. In the meantime they can't pay back the debt and higher interest rates will aggravate the debt level, an so on.... like in the last 40 years. The anticyclical fiscal policy worked during recession or slump but debt was almost never reduced during the recovery and boom. One exception to the rule happend during the Clinton admin. when Clinton reduced the debt while Greenspan lowered interest rates.

If you are going to comment on this blog at least try and be informed. Interest rates in France, Italy and Spain have fallen substantially since 2012. Basically OMT worked (opposed by Germany). There would be no capital market panic if public investment increased. The whole point is to stop wasting resources in the short term, so what you say about long run effects is completely irrelevant. And governments are quite capable of reducing debt outside of recessions - try looking at some data. Maybe we could design some sensible fiscal rules to encourage them, rather than the nonsense the Eurozone currently has.

Any proof for any of the deficit countries?Only at the start of the euro, a country like Italy brought down debt a bit, as they were under enormous pressure. But soon after they basically stopped bringing down debt, far before the financial crisis hit them. Point being, good or bad times, there will always be excuses or reasons not to bring down debt. Is there anyone seriously believing the deficit countries will bring down debt?The markets don't, they believe that the ECB or surplus countries will pick up the bill. All that has been achieved is buying more time, just push forward the bill to the next generation.

To SW-L:"If you are going to comment on this blog at least try and be informed. Interest rates in France, Italy and Spain have fallen substantially since 2012."

I'm not talking about the past! After Draghis "Whatever it takes..." and after OMT the spreads declined. I asked "What would happen to the spread of interest rates?" if additional public investment were financed by increasing the debt. Ok, you expect nothing serious will happen.

And, why are long run effects irrelevant? Because we are all dead - in the long run?

I recently found an economic paper (by none other than Alesina) which claimed that the US didn't have a European style welfare state because of racism. Essentially, good upstanding hardworking whites don't want their money to go to "those people", i.e. poor African-Americans.

Regardless of the argument's veracity, I think it illuminates very well what the ultimate problem with the euro is: a fair share of the German people, including some very prominent media outlets, are basically racist towards southern Europeans, in particular Italians (maybe it's because of being backstabbed in two successive World Wars, or never winning a World Cup match against Italy, I don't know).

That makes it essentially anathema for a German politician to support any kind of policy that would see German money flow towards Italy. I hear that often enough, "we have paid enough already!", as if Italy had actually received a penny from Germany (of course, Italy has paid about 70bn euros into various European rescue funds, most of which has found its way back to German and French banks).

No appeal to rationality will ever bridge what is essentially an ethno-national problem. Yes, that means admitting the failure of the European project to create a European demos. That's pretty much what the German Constitutional Court said in 2009 in its sentence over the Lisbon Treaty, if you care to look it up.

The solution is of course going back to Italian politicians ruling in the interest of the Italian people, and same for Germans, and take it from there. I seem to recall Italy being richer than both France and the UK on a per-capita basis, and closing in on Germany, before 20 years of economic integration under EMU dragged us all the way back to 75% of core-EU GDP per capita.

I trust that the euro will break up, and Germany will face its economic reckoning, as surplus countries always end up doing. Germans being Germans, they will keep doing the wrong things until the bitter end. Italy, of course, will backstab them much earlier.

(BTW, a quick one for the structural reforms cultists: look up the OECD Labour Protection Index. Compare Italy and Germany over the past 20 years. Then please shut up forever.)

I think you forget(or don't mention it) that there is also a moral harass problem, and the Germans are not irrational about thinking that especially the countries in the south will rely on Germans taxpayers. So if you stimulate outside Germany then the Eurozone can end as a transfer union, where Germans pay. So you can discuss if and how much the Germans should pay, and no country wants to pay to another country. This never ending discussion is a result of the Euro, so it had become more tempting to just break up the Euro, even if there are big uncertainties.

The moral hazard problem is not big now, but it has been just a few years ago where the rate spread of government bonds in south Europe to Germany was big. Also you can argue that if you want to solve the moral hazard problem, you have to commit to not spend to much, and sadly the only time when commitment is credible is in bad time, and then we have austerity. This problem is just created by the Euro. I also agree that today we have to much focus on the moral hazard problem, and to much on the moral hazard problem.

"Under this anti-Keynesian view the chart above has nothing to do with fiscal contraction, so it must be all about the lack of ‘structural reform’ outside Germany."

No. Under this anti-Keynesian view your chart was hand-picked to extrapolate growth based on a period of an artifical, credit-induced boom which has its roots roughly in the mid-90s, when it became apparent that monetary union was coming and future Eurozone member state bond spreads began to shrink. That cheap credit has been squandered - for example in Spanish real estate.

"Logically the only way Germany can avoid above 2% inflation is if the Eurozone as a whole goes through a prolonged depression, but as is painfully obvious from the comments on some of my recent posts, the German public is not told about this."

How can the German public not know? See, that's your fallacy. The German public is well-aware of conditions in Greece or elsewhere. But it attributes those conditions to the individual nations themselves and doesn't feel responsible for lifting them out of their depression. Which brings me back to the above point of squandered credit.

One thing you can surely expect from the German public: that it will not readily suffer for the consequences of malinvestments (or even consumption! see Greece) by other nations. The EU is not a federal state but composed of souvereign nations; every nation has to keep their own house in order.

But there is an additional aspect from the German POV: becoming cheaper means the EZ companies can potentially increase global market shares, increase exports and thus partially export the calamity away. In theory that should help ease the depression.

Finally, the Germany public doesn't mind if the EZ goes to less than 2% inflation for a prolonged time, if that's what it takes. The ECB has a toolbox with which it can try to counter that, but it better not overstep its boundaries. If the tools are insufficient to get back up to 2% quickly, so be it.

Trend growth of less than 2% does not sound that artificial to me. There was excessive growth in the periphery, as I have often said, but this was offset by low growth in Germany. The ECB cut interest rates until 2005 in response to slow German growth:

You may need to recalculate, I think. If credit has been flowing into today's crisis countries in hopes of higher profits, it means that without this (squandered) debt party GDP overall had been lower. German money would have flowed more into boring, lower-yield domestic projects or outside the EZ. The result would have been higher GDP for Germany, but more than offset by much lower GDP for PIIGS with a net growth below your trendline.

And if you would reduce average growth to 1.45%, you end up where we are today. Is 1.45% realistic? Maybe not. But if you assume only 1.6% growth then the effects of crisis policies are not as devastating as you make them out to be.

Not that I approve of crisis policies which basically come down to "Let's try to muddle through until the German public has had enough time to get used to the idea of debt pooling".

I am always surprised, in these discussions of German economic performance vs. rest of Europe economic performance, by the lack of attention paid to geography. A significant contributor of Germany's competitiveness drive for the last 15 years has been the ability of its firms to profit from their proximity to masses of well trained, cheap, and often German speaking resources East.

I happen to work in an American automotive company based in Germany. Let's take an example. I you're the head of a Munich-based second tier manufacturer, you jump in your car, drive 3 hours, and you're in Czech Republic where the effective cost of a good quality engineer is between 1/3 and half of their German counterpart. they will also often speak German.If you're the head of the same company near Lyons in France, you drive to the TGV station. From there you take a train to Paris where, if you're lucky, you have a direct plane to Prague where you either take another plane to your final location or drive another 3 hours. After a full day on the road (and anything between 1000 and 2000 eur of expenses, you're now ready to do business... This before taking into account all the historical links that still exist between Germany and its hinterland.

This is not to excuse the real lack of structural reform in Southern Europe, but rather to illustrate the fact there is a lot less "effort" to German recent competitivity than sheer geographical luck (and good historical timing, what with the integration of the east taking place at the same time as globalization part 2).

I think this is a good illustration about why investment often has a bias towards certain regions, and why we get core and peripheral areas and not always equilibrating ones like neo-classical theory suggests. But also I agree with the last paragraph of guillaum very much.

Aha! I'm glad to see you are coming around to my theory Simon! ;-) http://worthwhile.typepad.com/worthwhile_canadian_initi/2014/09/why-are-lawyers-against-higher-inflation.html

I can't help noting that the Canadian PM is an economist by training. And despite being seen as a very conservative politician, and despite Canada having achieved a hard-won budget surplus in the mid-90's (credit due to Liberal lawyer PM and lawyer Finance Minister) that had lots of popular support, he broke the consensus and deliberately increased G (especially on infrastructure investment) and deliberately created a deficit when the recession hit. And then started tightening again as soon as the Bank of Canada lifted off the ZLB. You would strongly approve of his very NK textbook fiscal policy.

Germany's interests and the general interests of the Eurozone are at odds.

It is fair to say that the European component of the global financial crisis has exposed a certain indifference to suffering in the German psyche (especially when it comes to die Ausländer) and also shown how the cult like grip of ordoliberalism on the German establishment makes it unable to understand macroeconomic policy (or even accept that it should exist).

However these issues have always been there.

The central problem for the EU is that its political structure and institutions (and specifically EMU) has combined with the exigencies of the European component of the global financial crisis to make these domestic German idiosyncrasies into official Eurozone policy and that these policies can not be changed without German approval.

Given that the current EU economic and monetary policy set (eg: the idiocy of the fiscal compact, ultra low inflation) serve Germany well from the points of view of financial self interest, international political power and ideologically (Those lazy southerners will follow our rules! Debt to Germany is sacred!) why would they want change? Given that Germany does not want change and that policy can not be changed without the country's agreement how would change happen?

The current phony war over policy would have to turn into an international political confrontation before we saw any change in policy and that change might have to involve the end of the current strain of EMU. What EU politician has the nerve or integrity to risk that?

Some politician from the two most extremist countries in this story, one being Germany itself (it's laughable that the current ruling coalition thinks itself moderate) and the other probably being a Greek leftist party, since this is the country that has been hurt more in this story, if you look at the macro stats on the Economist page it really stands out: 27% loss of GDP in 5 years, 50% of the population below the poverty line, and almost 28% unemployment! I mean, these are war-time, devastation stats...

It is not so much about the quality of German economic doctrine as it is that the export of this doctrine to the Eurozone has had such measurably awful effects. To paraphrase Stephen Colbert "Economic reality has a well known Keynesian bias."

Clearly German economic policy preferences in Europe is hurting almost everyone else in the Eurozone. Even core members of the Deutsche bloc like Finland and the Netherlands have performed badly under the mantra of balanced budgets, structural reforms and privatization.

Why does the government of a state of 80 million people get to cause various degrees misery for 200 million people? How did Germany's interests become paramount? Why will no one say stop?

I'm looking at Greek debt, unemployment, ppp and gdp at tradingeconomics.com right now, and it's perfectly clear that devastation of this level never happened, ever, while they had their own currency, I'm sure mismanagement was to blame for Greece being the second poorest country in the EU though. But now we're talking about a whole other level, it can only be described as a humanitarian catastrophy. I doubt that the crooks themselves are to blame, unless they somehow went suddenly completely mad in 2002, or started a war or something that we've never heard about (cause that what their stats look like). The depression is just *too* big. And the current account charts of Greece, Spain, Ireland etc look suspiciously similar, almost the same, from the moment they enter the Euro in 2002, despite great differences in their economies otherwise. It's obvious there are EZ wide systemic reasons behind this. Individual mismanagement cannot explain what's happening.

what conspiradcy theories? Systematic sudden large capital inflows and synchronous austerity in the North is a conspiracy theory?!? That's news to me. That's exactly what happened. History is not a conspiracy theory, any more than the allied Normandy landings for example were a "conspiracy". I suppose by your logic that eg the European Commision is a group of conspirators and their policies are conspiracies....

BTW I'm looking now *at the sources* of this article in wikipedia: http://en.wikipedia.org/wiki/Greek_Financial_Audit,_2004#2004_financial_audit since from the beggining of the euro crisis I've learned to ignore most european media outlets, and only read marcoeconomic papers on the subject, economists' blogs like this one, voxeu.org, and eurostat and commision reports. It seems to me that the infamous "Greek Statistics" argument about the euro *is* a media generated conspiracy theory, a media trick designed to get attention away from the flawed design of the euro, and play a morality blame game instead.

I'm quoting the article below, you can check it, and its sources, for yourself on wikipedia:

"Instead, the government produced new estimates while investigating the years 1997 - 2003, and the resulting data was given to Eurostat, which then went on and published a report.[9] The requirement that the 1999 budget deficit should have been below 3% of GDP was one of the key criteria for Eurozone entry; thus, its revision to 3.1%, The precise figure was actually 3.07%, according to Eurostat (AMECO), led to a controversy about Greece's admission.

Most of the differences in the revised numbers were due to a temporary change of accounting practices by the new government, i.e., recording expenses when military material was ordered rather than received. However, it was the retroactive application of ESA95 methodology (applied since 2000) for the years 1997-1999 by Eurostat, that finally led to a reference year budget deficit of 3.07% of GDP in 1999, leading to claims that Greece had not actually met all the accession criteria.

In the 2005 OECD report for Greece (p. 47) it was clearly stated that “the impact of new accounting rules on the fiscal figures for the years 1997 to 1999 ranged from 0.7 to 1 percentage point of GDP; this retroactive change of methodology was responsible for the revised deficit exceeding 3% in 1999, the year of EMU membership qualification”. The above has led the Greek minister of finance to clarify that the 1999 budget deficit was below the prescribed 3% limit when calculated with the ESA79 methodology in force at the time of Greece's application, and thus, since the remaining criteria had also been met, was properly accepted into the Eurozone. ESA79 was also the methodology employed to calculate the deficits of all other Eurozone members at the time of their applications.

The original accounting practice for military expenses was later restored in line with Eurostat recommendations, theoretically lowering even the ESA95-calculated 1999 Greek budget deficit to below 3% (an official Eurostat calculation is still pending for 1999).

An error very frequently made in press reports, is the confusion of the discussion regarding Greece’s Eurozone entry with the controversy regarding usage of derivatives’ deals with U.S. Banks by Greece and other Eurozone countries to artificially reduce their reported budget deficits. A currency swap arranged with Goldman Sachs allowed Greece to “hide” 2.8 billion Euros of debt, however, this affected deficit values after 2001 (when Greece had already been admitted into the Eurozone) and is not related to Greece’s Eurozone entry."

''It is fair to say that the European component of the global financial crisis has exposed a certain indifference to suffering in the German psyche (especially when it comes to die Ausländer) and also shown how the cult like grip of ordoliberalism on the German establishment makes it unable to understand macroeconomic policy (or even accept that it should exist).''

I already suspected it's about more than just disagreement about economic theory in this discussion. Thank you for showing your true colors.

well, yes in a way, and the same kind of swap was used by several other governments too. But what I'm trying to say, is that all this is just misdirection, the problem stems from current account imbalances and inflation differentials, not public debt, again eg Spain and Ireland had the lowest debt levels in the EZ, and were the only countries with surpluses, but it didn't matter at all, their fate was the same as Greece and Portugal, and even Italy up to a point.

The Euro is a badly designed currency with flawed institutions. If you ask me, the only one that has it right in Germany (and the only real hope I see for Europe) is the AfD.

"Nevertheless, there might be systemic reasons. Could you explain them without recurring to conspiracy theories?"

Gillaume's comment above is a very revealing first hand account about how the southern European countries got into serious trouble when they faced intense competition with the expansion of the EU single market (in addition to that of low-skilled manufactures from East Asia). These pressures intensified weaknesses that were already there. To understand Greece's problem, for example, you would have to study how it became a backward agrarian state during 500 years of Islamic occupation., leaving it with a structural terms of trade problem.

All these things highlight the importance of context and why you should not keep drawing on Model.

That being so, what reasons have we to believe that Simon Wren-Lewis's recipes will help them?

They have been independent for about 190 years, so they had time to learn. Their first default was in 1826.

And other countries have difficult histories too: In the 30 Years' War 1618 to 1648 (less than 500 years ago), a third of Germany's population was killed. In 1850, not long after Greece's independence. Germany was mainly agrarian. So it is possible to catch up. Think of South Korea and other countries.

This why you need to study Development Studies ala that was done in the UK before about 1980s. Why did East Asia move out of the periphery, but Africa, South America and the Middle East did not? To understand this growth theory is not enough - in fact it is better done without it. Big in the picture is political and social factors. It seems that for a country to enter the international capitalist system as an autonomous entity certain preconditions need to take place (in Japan and China this was done when they were closed systems and foreigners not allowed to dominate).

Your question is an important one and another good example of how your interdisciplinary study to answer it - and history BEFORE model.

But to answer your question it needs a German style Marshall Plan with German direction and supervision of the use of those funds given the weaknesses in Greek institutions.

Well they will have to call it something else. I would suggest calling it Eurozone fiscal union.

On the consequences of colonialism on development, the most successful examples for industrialisation was that of Japan over Korea, China and Taiwan. Colonisation by European powers was much more economically exploitative than the Japanese variety.

But again, obviously not a pleasant experience they would want to repeat, despite laying the foundations of successful industrialisation!

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